Accredited Investor game

Investing in publicly traded companies, either by purchasing an equity position or debt instruments, is relatively safe in today’s securities markets.  That is to say, you’re not likely to be buying “blue-sky” from a scam artist.  In the early part of the 20th century, lawmakers wrote “blue-sky” laws to prevent such practices and eventually led to the creation of the Securities and Exchange Commission (SEC).  The SEC requires companies who want to sell their securities to the public to register their securities with them.  However, every rule has its exemptions.  For this rule, the exemption is known as “Regulation D”.  There are a few variations to this rule, but for the most part, Regulation D requires companies to limit their offerings to institutions, businesses, trusts, and individuals who qualify as an accredited investor.  Many physicians often qualify as an accredited investor, but should they exercise their ability to invest in securities that aren’t registered with the SEC?

What’s an Accredited Investor?

As mentioned above, accredited investors can be a non-natural entity or an individual person.  I’ll be focusing on the definition of an individual person.  To qualify as an accredited investor, one of two criteria must be met.

Income

An individual (or spouses) who has had income exceeding $200,000 in each of that past two years and a reasonable expectation to earn that in the current year.

Net Worth

An individual (or spouses) with a net worth of $1 million, excluding their primary residence.

So what’s the philosophy behind this?  If you earn enough income or have accumulated enough assets, you must be savvy enough to invest in potentially risky securities, right?  I’m not so sure I agree with that line of reasoning, and perhaps the thresholds need to be updated, but that’s what we’re working with.

Investment opportunities

Once you’ve met the criteria of an accredited investor, what kind of opportunities does this open up to you?  The following examples are some common opportunities but aren’t an exhaustive list.

Hedge Funds

Hedge funds work using the same concept as mutual funds by pooling assets together to be invested by a professional manager.  The difference is that hedge funds aren’t regulated nearly as heavily and therefore must restrict selling shares of their fund to accredited investors.  Hedge funds use a wide variety of strategies from actual “hedging” strategies to protect capital, to very aggressive strategies involving the use of margin, shorting positions, derivatives, and timing.  Despite their advanced nature, the use of these complicated strategies hasn’t paid off in recent years.  The Barclay Hedge Fund Index reports poor performance compared to the stock market in general.

Index

2013

2014

2015

2016

Barclay Hedge Fund Index

11.12%

2.88%

0.04%

6.09%

Vanguard Total Market (VTI)

33.45%

12.54%

0.36%

12.83%

Hedge funds have a different compensation method known as the two and twenty method.  This means investors pay 2% in assets under management, plus a 20% performance fee.  With poor performance and high fees, it’s no wonder so many institutions are firing hedge funds in mass.

Private Equity

Private equity is a very high-risk/high-reward approach to investing.  There are many ways to go about it depending on the level of involvement you want.  Private equity firms buy majority positions of mature companies, venture capital firms usually buy minority positions in young companies with high growth potential.  If you really want to get personal, angel investing is an approach where you buy into companies on your own accord.

If you have a taste for getting more involved with your investments, I would recommend waiting until you have already accumulated enough wealth from savings and traditional investing that you can set aside some “play money”.  This is a portion of your wealth that you would be willing to put at high risk without causing financial distress if you lose it all.

Ambulatory Surgery Centers

During the course of your career, you may have the opportunity to invest in an ambulatory surgery center (ASC).  While you many not have to be an accredited investor to participate, I felt it worthy to include because of the similar nature.

Maybe I shouldn’t assume you already understand what an ASC is and how it works, so in a nutshell…Often physicians will buy into a facility that only performs outpatient surgery.  Physicians who invest, also typically will work out of these facilities, usually surgeons and anesthesiologists.  This is likely the most personally involved investment you will participate in.

Risks and Rewards

Understanding what it takes to be an accredited investor and what types of investments are available, you should ask yourself why you would and wouldn’t want to make such investments.

Higher Returns

A general rule of investing is that the greater the potential risk, the greater the potential reward must be.  If this weren’t true, it would only make sense to invest in treasury bonds backed by the full faith and credit of the U.S. government.  But if you want to get a higher return than what is considered “risk-free”, you have to take on some level of risk.  Many of these investment opportunities are quite risky and you should seek a return that is on par with the level of risk involved.

Low Correlation to the Stock Market

When developing a portfolio, an important factor to consider is the amount of volatility you may experience.  The most common way this is done is to find a balance between stocks and bonds.  We know that stocks are a lot more volatile than bonds, and thus have a lower correlation to each other.  If you’re uncomfortable with the volatility of stocks, you can reduce it by adding bonds to the mix because of the low correlation.  How much depends on your level of comfort.  This is also true with other types of investments.  Perhaps you invest in an ASC and it’s producing income, this income is likely to continue even if there is a stock market correction and your stock positions are down.  You’ll have the income you need in the short term while the stock market rebounds.  If you’re only invested in one type of asset, you are at its mercy when that asset’s market cycle is down.

Loss of Capital

There are many types of risk.  When talking about the stock market, usually the type of risk you’ll hear about is volatility.  This is simply the ups and downs markets experience.  It’s not that big of a deal when you are well diversified because markets are cyclical and it’s normal for prices to rise and fall.  When getting involved with investments that require you to be an accredited investor, the risk now becomes the loss of capital.  Many private equity investors know full well, and expect, that they are going to pick some losers and the capital invested in those losers will be lost.  But there’s a floor to how much you can lose.  However, they also believe they will also pick winners who have virtually endless potential to grow and that the growth of the winners will outweigh the loss of the losers.

Lack of Liquidity

When checking out these types of investments, be sure to understand how long your assets will be committed.  In some cases, if you want or need to get out, you may be on your own to find a buyer.  For example, if you bought into an ASC and you decide to move and sell your share, you’ll have to find someone to buy you out.  Depending on the profitability of the center, you may have trouble getting your investment back.

Due Diligence

A major feature you are giving up with regulation D securities is that the SEC isn’t doing much due diligence to prevent fraud.  Companies offering securities under this exemption simply have to file a short form.  It’s up to you, the accredited investor, to take the time and put in the effort to check out the company you’re interested in.  Find out as much as you can and consult with an expert in that company’s domain.  Certain risks are out of our control, but doing your homework isn’t one of them, so be thorough.

Large Minimums

I previously recommend having “play money” set aside for these types of investments.  A problem you may run into, though, is many opportunities require a very large minimum investment.  The minimums can vary, but I’m talking about $50,000 and greater.  In general, your “play money” should comprise of somewhere between five and ten percent of your overall wealth.  If you do the math, that puts you right at around $1 million in wealth, which happens to be the same threshold to be an accredited investor.

Is it Worth it?

With the basic facts laid out in front of you, only you can decide if it’s worth it.  Generally, I recommend plain vanilla investments that aren’t highly speculative.  To realize a greater return, you must treat it seriously and take the time to do it right.  Perhaps you’re willing to put in the effort, maybe it could even be a form of entertainment to you.  It can be very exciting to speculate.  If that’s the case, go for it.  Don’t, however, think that you need to get involved in this type of investment.  You’ve already made a great investment in yourself to become a physician and are rewarded with a high yielding salary.  With proper planning and discipline to follow your plan, you can achieve financial independence with those plain vanilla investments.

So what do you think?  Why would you want to participate in regulation D securities?  For the potentially higher returns?  For the thrill?

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